Developing India's capital markets
This report was researched and compiled by Christopher Hindle and Marie Verpilleux of Global Business Reports
India's recent progress towards economic liberalisation has entailed wide-ranging measures aimed at improving India's economic performance right across the board. Perhaps none, however, have been as successful as those applied to the country's financial markets. "The development of the institutions, regulations, and practices surrounding India capital markets is on a par with the best in the world," says Subhash Aggarwal, chairman and managing director of SMC Global, one of India's investment solutions companies. "The development of the country's capital markets has played a significant role in facilitating investment and economic growth. It continues to evolve, offering more opportunities for both foreign investors and, with the added potential of the Indian retail sector, for India's financial services sector too." With stock markets that have outperformed the global indices for the best part of a decade, the recent history of India's capital markets is one of significant achievement. A spectacular phenomenon but one with a certain pedigree.
The Bombay Stock Exchange is, in fact, the oldest stock exchange in Asia. Established in 1875, after rowdy street-traders were encouraged to move from under the Banyan trees in front of the old Bombay Town Hall to find a more suitable home, the BSE has since grown in size to become the biggest stock exchange in the world in terms of the number of listed companies. Following a stock scandal in the early 1990s, the government instigated the formation of the National Stock Exchange (NSE) as an automated, paperless exchange, with its key index the S&P CNX Nifty - better known as the Nifty - an index of fifty major stocks weighted by market capitalisation.
Though other exchanges still exist, the BSE and the NSE are dominant and, continuing to grow in competition with one another. Combined they account for most of the share trading in India. With over 7,000 public companies listed between them, across a full spectrum of business sectors, the breadth and depth of India's capital markets makes the country a stock pickers' paradise. Reforms in recent years have included the implementation of advanced electronic trading systems in the two primary stock exchanges, the demutualisation of securities issues to allow for straight-through-processing and electronic settlement on a T+2 settlement basis, the implementation of state-of-the-art safeguard mechanisms to ensure the safety and integrity of the markets and the development of a sophisticated set of securities regulations.
"In today's trading environment, you need an efficient capital market, network linked in real time and with a good settlement history, which is what the Indian market offers," comments the BSE's managing director and CEO, Rajnikant Patel. Developments have all been monitored and enforced by the very capable and professional securities regulator, the Securities and Exchange Board of India (SEBI). Whereas a couple of years ago many might have complained that the reform process was slow - for example, the country did not go overboard into the derivatives and futures segments - given recent economic conditions, most involved in India's capital markets are now very appreciative of SEBI's cautious approach. Although some see that challenges remain in terms of fixed income, securities lending and borrowing - the short term opportunities that global investors seek - there is confidence that these will be resolved soon enough.
As Patel also notes, India's achievement in the development of its capital markets is all the more important when one considers the country's approach to foreign investment since liberalisation. Whilst many emerging Asian countries went down the foreign direct investment (FDI) route, India has until recently been generally much slower in removing caps on FDI. Instead, the country has relied on encouraging foreign institutional investors (FIIs) to invest in the country's primary and secondary capital markets. "When you compare China and India from an FDI perspective, you see that the main chunk of FDI goes to China. However India gets the greater share of FII," says Patel. "FII is a faster moving form of investment and the level of FII in India shows that investors have confidence in the ease of accessing and exiting the market here."
India's success in attracting foreign investment this way is clearly demonstrated by the number of FIIs now registered with SEBI, which increased from less than 1,000 at the end of 2006 to 1,219 by the end of 2007. The number of registered FII sub-accounts has also risen significantly to 3,644. Having registered as FIIs, large international asset managers have also gone on to set up a plethora of India-focused funds bringing money into the country, typically through offshore havens such as Mauritius.
In addition to this, recently, Indian companies have even started using the FII route to expand their platform for investment into the country. Kotak Mahindra (UK), the international subsidiary of India's financial boutique house Kotak Mahindra group, was the first Indian company to take the direct FII route to invest foreign money in India. "We want to position ourselves as the leading asset management company bringing funds into the country," says Paul Parambi, (pictured left) head of international business at Kotak Mahindra. "Yes, there are lots of India-focused funds already, but what differentiates us is the ability to offer a diverse range of specialised funds right across the spectrum that focus on a select class of Indian equities." Some fund managers would also claim that Indian asset management firms will have an advantage of better market knowledge of the Indian market compared to the traditional FIIs and that this may be an increasingly attractive area for the leading India companies to enter.
Since December 1993, cumulative net investments by FIIs in Indian equities totalled $66.8bn by the end of 2007. According to a study by Citigroup Research, FII holdings in Indian companies are greater than that of all the domestic financial institutions, including mutual funds and insurance companies, the retail sector and high net worth investors (HNIs) put together. "Everyone can see that it is the FIIs that have really been calling the shots," comments Amisha Vora, joint managing director of Prabhudas Lilhader. She notes that while FII investment was the cornerstone of the phenomenal rise of the Indian stock markets over its five-year bull run, FIIs' role in causing the volatility seen in markets so far this year should not be understated either. Turning net sellers in the last two months of 2007 to counter their sub-rime loses, it was largely the withdrawal of FII money that sent the country's stock markets sliding during the first quarter of 2008. "If global investors do not invest in India from a long-term perspective, then the economy can be damaged by having money pulled out at such a fast pace," warns Shachindra Nath, (pictured right) group COO of Religare. "If the global investment fraternity wants to make money out of India it has to be with a long-term perspective."
The concern about the amount of ‘hot money' that India attracts remains, but despite the shocks of the past few months, spirits have not been greatly dampened. FII inflows have already started to pick up again and there is confidence that the underlying value inherent in the Indian growth story. Most reckon investors will be willing to make the long-term commitment that the country needs. "Yes, because of the large global flows of capital in terms of equities, the coupling is stronger than on the debt side where we are well insulated. But corporate earnings will continue to grow at some 15-18%," comments Milind Barve, managing director of HDFC Asset Management. "My sense is that at the bedrock, economic growth remains very strong and that in terms of allocations, global investors cannot ignore an 8-9% growth story for very long."